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What Investors Should Ask Their Fund Managers or Advisors

There have been many unfortunate stories about investors being lied by some unethical investment managers managing other people's money (e.g.: the biggest example is, of course, Madoff fraud) for the past few years especially last year. Consider these frauds:

  • Bernie Madoff - $50 billion fraud
  • R. Allen Stanford - $8 billion fraud
  • Donald Pang- $4 billion fraud
  • Samuel Israel - $400 million fraud
  • Arthur Nadel - $350 million fraud
  • Marc Dreier - $380 million fraud
  • ...and so on.

As a result, US government officials these days overall are moving fast toward creating and implementing more stringent regulations to various types of investment companies especially hedge funds. In our view, US government is moving to the right direction (as long as it does not go too far.) However, even without enforcements of regulations, investors should, can and need to protect themselves and reduce risks of frauds

Although we don't have perfect answers, we believe we have come up with  potentially sound solution to reduce frauds in the finance & investment area (potentially applicable to private equity funds, hedge funds, separately managed accounts, business development companies that raise capital from private investors, commodity trading firms, investment advisors, any individuals and/or organizations that manage other people's money, etc.) We have solutions in the form of simple yet implementable recommendations for investors anywhere who are thinking about investing or have invested in any private equity funds and/or hedge funds regardless whether you are super-rich or merely rich and whether the funds and/or fund managers are famous or not, funds size is big or small, leveraged or not.

We believe now more than ever investors nowadays regularly (at least annually) should demand and request several key items/evidence below from their investment managers/advisors/sub-advisors to significantly reduce risks of frauds (or perhaps identify on-going frauds):

1. Registered investment advisor proof (depending on the legal domicile of the advisor, it may or may not be required) with all the filing properly submitted and approved. 

2. Fully audited performance proof by respected independent CPA firm where the CPA firm is not related to the fund nor the fund manager. 

3. Evidence of legal formation and domicile as well active business licenses & compliance status of the investment management company including the investment advisor and sub-advisor.

4. Evidence of legal formation and domicile as well active business licenses & compliance status (could be on-shore or off-shore) of the investment funds including the master fund and feeder fund where your capital is/will be invested in.

5. Background check evidence of all the key investment managers (the key persons/team managing your capital) to ensure there have been no criminal history or fraudulent activities in the past and to ensure what they say are true and correct (e.g.: education background, working experience history, license, etc.)

6. Evidence that stated risk management strategies and investment strategies are implemented properly and accordingly. When an investment manager/advisor/sub-advisor state on his/her presentation that he/she do not and will not engage in any leverage at any time to juice up return, then the fund/account the he/she manages should not have any leverage at any time.

7. (Optional) If you have direct access to the key persons managing your capital, we encourage you to socially meet and talk to him/her more often and look deeply at his/her eyes and ask this very important question to yourself: "Is this investment manager a truly good, trustworthy, ethical, honest person with high integrity whom I can entrust my capital with?"

Without ability to provide majority of the above items/evidence quickly and smoothly (note: for smaller investment managers who are just starting, they may not have all items, but at least should explain  to their investors when, where, what, how the above evidence will be available), obviously the investment managers/advisors and their organizations do not have them ready and/or have not yet gone through the efforts to obtain the minimum requirements regardless how pristine their appearance, how high (or low) their social standings, how timely their market calls and opinions are. If it is too good to be true, it probably is.

Sooner or later, we believe the following trends will accelerate:

  • Investors will increasingly demand more transparency from their investment managers. We think majority of high net-worth investors are not stupid to realize the needs to request the above seven evidence regularly every year at minimum.
  • Government will increasingly implement more regulations and transparency rules to financial organizations especially private equity funds, hedge funds and their managers. Don't believe it? US Treasury recently proposed highly anticipated Financial Regulatory Reform: A New Foundation. New era is coming to Wall Street.

Key message to investors anywhere:  

  • ARE YOU WILLING TO STEP UP, REQUEST & OBTAIN THE ABOVE EVIDENCE/ITEMS FROM YOUR INVESTMENT MANAGERS?
  • ARE YOU READY TO DO DEEPER DUE DILIGENCE TO PROTECT YOUR INVESTMENTS AND YOUR RIGHTS AS INVESTOR?

Key message to investment managers anywhere:  

  • ARE YOU READY TO PROVIDE THE ABOVE EVIDENCE/ITEMS?
  • ARE YOU WILLING TO DO WHAT IT TAKES TO ENSURE COMPLIANCE WITH ALL REGULATIONS AND SERVE YOUR INVESTORS WITH THE HIGHEST INTEGRITY?

"You only find out who is swimming naked when the tide goes out."  ~ Warren Buffett